“I’m here to convince you that fixed income is back as an attractive asset class,” said Benoit Anne, lead strategist of the investment solutions group at MFS Investment Management, during the Canadian Investment Review’s 2023 Global Investment Conference.
Two major factors mean allocations to fixed income are becoming increasingly attractive, he added. First, the U.S. Federal Reserve’s announcement it would raise its policy rate caused turmoil in fixed income markets in 2022. In concert with sluggish growth and high inflation, many fixed income allocations suffered during the year.
“Do you think the monetary policy shock is going to be as severe this year as it was last year?” asked Anne. “Of course not. Do you think the volatility on the growth and inflation front are going to be as bad? Probably not.”
The second factor for optimism about fixed income in 2023, he noted, is they’re close to the highest yield levels observed over the past 10 years. “They’re very attractive across the board. That income part is the most predictable and stable component of total return in fixed income. When you start with it at a higher level, it’s a game changer.”
Fixed income allocations could see yields of around six per cent over the next five years, added Anne, though he cautioned there could be some significant disruptions. “I’m not that nervous at this point in time — it’s all going to be about measuring the risk to spreads versus the risk to rates and those are going to upset each other.”
Despite the possibility of disruption, he noted fixed income looks likely to outperform equities in the next five years. “Everybody’s saying there’s going to be a great return for the 60/40 portfolio — that’s because fixed income is back and doing the hard work. . . . To see 4.75 per cent returns in a global fixed income portfolio in 2021, it took a lot of emerging market risk.”
In 2022, a globally diversified fixed income portfolio generated median returns of 6.5 per cent, added Anne. “But if risk is your thing, fixed income can do that as well. . . . That would involve taking on a lot more risk by adding more high yield and quite a bit more from emerging markets.”
The customizability of fixed income also makes it an effective replacement for cash in liquidity-starved portfolios, he said. “I like short-term credit. . . . Short-term credit gives you a lot of protection, higher yield than cash . . . and it positions you for pretty sizeable expected returns going forward.”
Institutional investors with strong domestic biases are also positioned to generate exceptionally strong returns in 2023, added Anne. “I like Canadian fixed income because it’s one of the cheapest asset classes within global fixed income. . . . But I like emerging market better.”
His confidence in emerging market fixed income stems from his belief the U.S. dollar is overvalued and emerging market economic growth appears to be likely to exceed that of developed markets. “If you enter [now] with yields at roughly nine per cent, you’re well positioned to see double-digit returns over the next five years.”
Read more coverage of the 2023 Global Investment Conference.